Red Hat (RHT) Virtualization Signal

Red Hat (RHT) continues to be not only a fascinating technology company, but a fascinating experiment in investor psychology. It has always been a good company for its customers, who benefit from its enterprise quality, low cost operating system, virtualization, and middleware. Yet the stock began highly overvalued during the first internet stock boom, became vastly undervalued in the crash that followed, and only in 2009 became somewhat overvalued again.

Yesterday's release of results for the quarter ending February 28, 2010, were quite good compared to realistic expectations, but investor's expectations were not reasonable. With Red Hat stock trading today with a Non-GAAP PE (price/earnings) trailing ratio of 41.4 and 40 times future earnings (per NASDAQ.com), meeting investor expectations was an unlikely scenario. You need faster sequential and annual growth rates to justify that kind of PE in this market.

On a GAAP basis, revenue was $195.9 million, up 1% sequentially from $194.3 million and up 18% from $166.2 million in the year-earlier quarter. Net income was $23.4 million, up 43% sequentially from $16.4 million and up 46% from $16.0 million year-earlier. EPS (diluted earnings per share were) were $0.12, up 50% sequentially from $0.08 and also up 50% from $0.08 year-earlier.

If the stock were at a reasonable price, those would be good numbers. But emotional investors who do not understand the technology market perpetually convince themselves that Red Hat is the next Microsoft. There is a big difference between being a great company in a niche and being the next Microsoft.

For the details you need to make your own analysis of the value of Red Hat stock, see my Red Hat Q4 2010 analyst conference summary and past summaries.

I have owned Red Hat stock at times; I currently do not own any. If sentiment shifts again and Red Hat becomes undervalued again, I might become a buyer. This in-and-out goes against my main line of investment thinking, buying undervalued stocks and holding them for the long term. But most of the stocks I invest in are not as volatile as Red Hat has been.

Compare Red Hat to Marvell Technology (MRVL). Marvell revenues in the quarter ending January 30, 2010 were up 65% y/y and 5% sequentially. Even taking into account the different business models (Red Hat income is subscription based, so steadier), it is reasonable to expect Marvell revenues and profits to grow faster than Red Hat in 2010 and 2011. Yet Marvell is trading at only 21.4 times past earnings and 13.9 times future earnings. Note that I own Marvell stock. But look at the PEs of other Nasdaq 100 technology stocks and you will see what I mean. Even Apple, which I frequently diss as overpriced, has a trailing PE of just 28 today; certainly no bargain, but not unreasonable.

There are a lot of technology stocks that offer better value than Red Hat right now. That is not because they are necessarily better companies (though some might be); it is just because of their relative stock prices.


More data:


http://www.redhat.com/

http://www.marvell.com/